Fed’s Tarullo Says Reviving Glass-Steagall May Be Costly

By Craig Torres and Joshua Zumbrun -
Dec 4, 2012

Federal Reserve Governor Daniel Tarullo said enacting a law similar to the Glass-Steagall Act
that separates investment and commercial banking could impose
“substantial costs” by curtailing the range of services
offered by individual banks.

Two other proposals, to place a cap on banks’ non-deposit
financing or to require firms to maintain certain levels of
long-term debt, may better reduce the risks that led to the 2008
financial crisis and brought down firms such as Bear Stearns
Cos., Lehman Brothers Holdings Inc., and American International
Group Inc.

“The reinstatement of Glass-Steagall would mean that bank
clients could no longer retain one financial firm that would
have the capacity to offer the whole range of financing
options,” Tarullo said today in remarks prepared for a speech
at the Brookings Institution in Washington. Another cost to such
a rule could be damage caused to the many small banks that
provide some capital market services to small businesses, he
said.

Tarullo, 60, has overseen the implementation of the Dodd-
Frank Act, the most sweeping overhaul of financial regulation
since the 1930s, and a reorganization of the Fed’s approach to
inspecting banks and ensuring financial stability. He was
Obama’s first appointee to the Fed and is the lead governor in
charge of bank supervision and regulation.

Government Support

The Fed and lawmakers in recent years have mitigated some
of the “too big to fail problem,” in which the collapse of a
firm threatens the broader financial system and would require
government support, Tarullo said in response to audience
questions.

“I would certainly not say it’s been eliminated,” Tarullo
said of the risk posed by too-big-to-fail firms.

In expressing skepticism about Glass-Steagall, Tarullo said
many firms at the center of the financial crisis in 2008 and
2009 were either stand-alone banks or investment banks, such as
Lehman Brothers and Washington Mutual Inc.

Such firms wouldn’t necessarily be subject to a break-up
under Glass-Steagall.

Capping a bank’s non-deposit liabilities as a fraction of
U.S. GDP has “considerable conceptual appeal,” Tarullo said.
Such an approach “allows relative flexibility to the firm in
meeting that constraint” since the firm could shrink its
balance sheet through selling any assets it wished.

Certain Size

If research showed economies of scale and scope in banking
were unlikely to be realized beyond a certain size, then policy
makers would “have a point of reference for setting the cap,”
he said.

Further analysis of the proposal would be needed, Tarullo
said, and may “suggest alternative means to the same policy
goals.”

A proposal to require banks to increase the use of long-
term debt “would not seem to carry significant hurdles,” he
said.

The central bank has used annual stress tests of banks’
capital strength to boost tier one common capital to $803
billion for the 19 largest banks from $420 billion in the first
quarter of 2009. The ratio of capital to assets weighted for
risk has about doubled to 10.9 percent from 5.4 percent.

Borrowing Costs

Bank profits have improved as non-performing loans have
declined and fee income from consumer banking has increased.
Also, mortgage refinancing is booming thanks to the Fed’s
quantitative easing strategy aimed reducing mortgage rates and
other long-term borrowing costs.

The KBW Bank Index, which tracks 24 large U.S. banks such
as Bank of America Corp. and JPMorgan Chase & Co (JPM), has increased
22 percent this year versus a 12 percent rise in the Standard &
Poor’s 500 stock index.

In the past two months, Tarullo has introduced two new
ideas for bank regulation. He said in an Oct. 10 speech that it
would be “appropriate” for Congress to legislate an upper
boundary for the largest banks that are able to preserve a
“too-big-to-fail” quality.

“We need to adjust the regulatory requirements for foreign
banks in response to changes in the nature of their activities
in the United States, the risks attendant to those changes, and
instructions from Congress,” Tarullo said.